A pattern of price gains into the end of the month and then into the first or second day of the new month has held again. This pattern also suggests the market might not hold onto those gains in the next week or two so we'll soon find out if the pattern will continue or not.

Today's Market Stats

The end-of-month rally that typically leads into a beginning-of-month rally has once again played out and now we're left to wonder what will follow the strong rally off the February lows. It's easy to feel bullish looking at the daily charts but the intraday charts are showing reasons for worry as the volume in the rally is less than what we saw in the decline and we're seeing waning momentum (bearish divergence). As we head into Friday's pre-market nonfarm payrolls report it will be interesting to see how the market reacts.

Much of the trading today is done by program trading (about 80%) and much of that trading is done by large hedge funds. These funds derive a good portion of their income based on their assets under management (AUM), such as 2% of AUM and 20% of gains (they don't give back the 20% if they lose money). It's to their advantage to have their AUM at as high a level as possible at the end of each month so that they can bill their clients 2% of the asset value. It's no coincidence that there's typically an end-of-month rally to get the AUM as high as possible.

February ended at the highest level since the end of January, which was the highest level since the end of December, which was the highest level since December 1st, which was the highest since November 3rd. These end-of-month rallies, into the first day or two or three of the new month, are typically followed by a swoon into mid-month as these buyers step away and then come back in later in the month to start all over again. Rinse and repeat, collect 2%. Many times these "AUM drives" begin in opex week. So with the rally from February 11th looking a little tired I'd be a little careful chasing the market higher from here.

Today's economic reports included the ADP Employment Change report in the morning and the Fed's Beige Book this afternoon. The employment report came in a little stronger than expected -- 214K jobs added vs. expectations for 190K and a slight improvement over the +205K jobs added in January. It was a positive sign for the economy but not too strong to scare the Fed into thinking they'll have to move faster on the next rate increase. The futures market barely reacted to the pre-market news.

The Fed's Beige Book showed U.S. economic activity slowly expanding from early January through February but not smoothly. There was a large variation across different regions and within the different sectors. Consumer spending increased in a majority of the districts but manufacturing continued to lag behind other sectors. The strong dollar continues to get the blame for deteriorating export business while the decline in demand from the energy field is hurting many ancillary businesses that feed this sector. While the employment picture continues to look stable there is some concern that wage growth "varied considerably."

The report noted consumer prices were generally flat and it makes it more difficult for the Fed to justify another rate increase. There is concern that a global slowdown will drag the U.S. economy down as well and without inflation ticking higher it's going to be difficult for the Fed heads to argue for a rate increase at this time. The market likes that and the added rally this afternoon was likely a result of thinking the Fed will be forced to stand on the sidelines. Of course the reason for the Fed not being able to raise rates is exactly why the market should not be rallying but that point seems to be absent from most investors' thinking.

Not showing up in the Fed's Beige Book is a discussion about U.S. small-business activity, which is slowing. As the biggest driver in employment this is worrisome. The Thomson Reuters/PayNet Small Business Lending Index dropped significantly, down -13% in January to its lowest level since November 2014. This is a measure of borrowing by small businesses and according to Bill Phelan, the president of the loan-information company PayNet, this level of borrowing is insufficient to replace old equipment, let alone buy more. As Phelan reported, "This is a dramatic form, an extreme form of hunkering down."

Along with other signs of contraction that we're seeing for the economy, Thomson Reuters notes the PayNet index is "a strong leading indicator for U.S. economic growth one or two quarters down the road." This makes sense, since small businesses account for a huge portion of U.S. economic activity. If they're struggling, the broad economy is likely to follow. This will of course continue to make it difficult for the Fed to justify a rate increase -- no/slow growth and no/slow inflation growth will necessarily keep the Fed on the sidelines. The conditions are not good for the stock market either but for now it continues to be focused on the Fed to the near-exclusion of all else. The market has its back to the woods and the bears are sneaking out to attack...

Now that we've had a strong bounce off the February lows, with many of the indexes having retraced 50% or more of the December-February decline, it has turned many analysts bullish again on the stock market. If my assessment of the market's decline is correct, which is that it's the first leg down of a new bear market, then the bounce off the February low is just a correction to the decline and it will be followed by a drop to new lows. The first correction typically gets traders feeling very bullish at the worst time since the next leg of the decline if often the stronger one. It remains to be seen whether or not this pattern will play out but at the moment I think it's risky to chase the market higher. However, the indexes are also close to proving the bounce is something more bullish than just a correction and we should get a better idea in the coming week who will win the battle.


S&P 500, SPX, Weekly chart

With the assumption that the bounce off the February 11th low is a correction to the December-February decline and not the start of something more bullish, there are some key levels that will seriously jeopardize that assumption. If SPX rallies above price-level S/R at 1992 I'd turn more neutral and if it can rally above its 200-dma, near 2024, and its 50-week MA, near 2033, I'd turn more bullish. If it can rally above 1992 and hold that level on a back test I'd also turn more bullish. But for now, until proven otherwise, the February bounce should lead to a stronger decline in a new bear market and the next leg down could be very strong -- down to the June 2007 high at 1576 by June, followed by a bounce before continuing lower into the fall, potentially down to the May 2011 high at 1370 (to set up an end-of-year election rally).


S&P 500, SPX, Daily chart

The daily chart of SPX is not showing any signs of topping and therefore it's telling bears to be cautious about shorting the bounce. There is no bearish divergence on the daily chart for the rally from February 11th, which is not required for a top but it helps signal an end to the move. But a broken uptrend line from January 20 - February 3 has been holding back the rally and it currently crosses price-level S/R at 1992, which is also the 62% retracement of the December-February decline. That makes 1992 an important level for the bulls to break through. The next level of resistance above 1992 is the 200-dma, near 2024, and then the 78.6% retracement (a favorite retracement level for this market) at 2041. A rally above 2041 would be a strong indication we'll get new all-time highs. But the bounce pattern off the February low looks like a correction and that has me looking for evidence for where it will end since the next leg of the decline should be a strong one and therefore a good opportunity to short it.

One important note about yesterday's strong rally -- it was the strongest rally since January 29th and August 27th before that. Both of those days led to only small gains the following day and then either a significant pullback (into September) or a new low (into February). In other words the strong rally was more of a blowoff move (short covering) than something more bullish. You'll find the strongest rallies in a bear market, not a bull market. Today's rally produced a small gain so if the pattern is to repeat we'll have a down day tomorrow. If it doesn't decline but instead closes above 1992 then we'd have a bullish statement from the market.

Key Levels for SPX:
- bullish above 1992
- bearish below 1891


S&P 500, SPX, 60-min chart

The 60-min chart below shows a rising wedge pattern for the bounce off the February 11th low and bearish divergence at the highs since February 17th, which helps confirm the bearish interpretation of the pattern. Today's rally was holding at the top of the wedge until a quick pop above it with a small jam higher into the close. A decline tomorrow would leave a small throw over above the top of the wedge, which is a common way for the pattern to finish. But a rally above 1992 would effectively negate the bearish wedge and that in turn would be a strong bullish signal. We should find out quickly Thursday morning which way this is going to go.


Dow Industrials, INDU, Daily chart

The Dow's daily chart looks like SPX as it presses up against its broken uptrend line from January 20 - February 3 and price-level S/R near 16900, which was this afternoon's high. The day following Tuesday's big rally finished with a bearish hanging man doji at resistance, which needs a red day on Thursday to confirm the reversal pattern. But if the bulls press this higher on Thursday, the next level of resistance is the 62% retracement of its December-February decline, at 16985, and then its 200-dma, near 17195. Not shown on its daily chart, there are two internal price projections, based on the wave pattern, for the bounce off the February low, both of which point to the 16900 area for an upside target. Having achieved its upside target at price-level resistance and with short-term bearish divergence and overbought conditions it's a very good setup for the bears. We'll find out quickly on Thursday whether or not the bears are paying attention.

Key Levels for DOW:
- bullish above 16,900
- bearish below 16,165


Nasdaq-100, NDX, Daily chart

It's hard to see on the NDX daily chart below but today's candle is a hanging man doji, like the Dow, and following yesterday's big rally it could be a reversal pattern in the making. A red candle for Thursday would confirm the reversal pattern but as long as it stays above the 50% retracement at 4321 it remains bullish. The next level of resistance is near 4420, where it would retrace 62% of its December-February decline, achieve two equal legs up for its bounce off the February 11th low and test its 200-dma. Needless to say, that will be a tough level to crack if NDX continues to rally up to there. The 5-wave decline from December into February is what strongly suggests the bounce off the February low is not a new bullish leg but instead is a correction to the decline. That's the reason I'm looking for a top to the bounce to get short. It might lead to only a pullback in what will become a larger a-b-c bounce pattern but the more immediate bearish potential is for a decline to new lows from here.

Key Levels for NDX:
- bullish above 4325
- bearish below 4088


Russell-2000, RUT, Daily chart

The RUT was a strong leader to the upside today and that's bullish. Whereas the other indexes rallied roughly +0.3% (flat for NDX, +0.4% for SPX) the RUT was up +1.1% and as long as the RUT leads to the upside it will be good for the market. Rallying above strong resistance near 1040 yesterday, along with the bullish follow through today, tells bears to be very cautious trying to pick a top. The next level of resistance, if reached, will be 1074 (a 50% retracement of its December-February decline) and then price-level S/R near 1080. A drop back below 1040 would be a bearish heads up.

Key Levels for RUT:
- bullish above 1040
- bearish below 996


10-year Treasury Note emini, ZN, Weekly chart

I typically follow the Treasury yields but following bond prices is essentially the same, except for the inverse relationship. I noticed an interesting setup on the 10-year Note emini contract (ZN), which is shown on its weekly chart below. The rally in bond prices from December had ZN breaking its downtrend line from July 2012 - January 2015 in February and it then rallied up to the top of a parallel up-channel for the rally from September 2013. It poked above the top of the up-channel on February 11th and then created a strongly bearish shooting star for the day. That rally has been followed by a drop back down to its broken downtrend line from 2012 and we'll soon find out if it's going to hold as support on a back-test. If the back-test holds and Treasuries start rallying again it would very likely coincide with a decline in the stock market so keep an eye on bonds to help gauge how much the stock market rally, or decline, should be trusted. If ZN drops below 129 it would be supportive of a continuing stock market rally.


KBW Bank index, BKX, Weekly chart

A bounce pattern for the banking index, BKX, would have two equal legs up at 64.68 (for an a-b-c correction to its decline) and at the same level it would back-test its broken 200-dma and broken 50-week MA, both currently at 64.67. That should be tough resistance if reached. But if the buyers rally BKX above 64.68 they wouldn't run into the next strong resistance level until about 66.50. As with the other indexes, the risk following the bounce off the February 11th low is for a strong decline to a new low but at the moment I can't rule out the possibility for just a pullback this month and then higher into April for a larger a-b-c bounce off the February low.


Transportation Index, TRAN, Daily chart

The Transports have had a strong recovery off the January 20th low, with practically no pullback along the way. The TRAN could retrace 62% of its November-January decline, at 7611, if the buyers can keep at it this week. The bounce off the January low would likely be complete if it drops back below 7100.


U.S. Dollar contract, DX, Weekly chart

There's not much to add about the US$ as long as it continues to trade inside a 94-100 price range. Short term there is a down-channel for the pullback from December, the top of which was nearly tested with today's high at 98.59 and the intraday pattern looks like the bounce could be ending at any time. Another trip back down toward 95 could be the next move but it would look more bullish if it can rally above its January high at 99.95.


Gold continuous contract, GC, Weekly chart

Gold's daily chart shows a sideways triangle consolidation pattern following the February 11th high and that looks like a bullish continuation pattern. As long as it holds above the February 16th low, at 1191.50, it's looking like we'll see another leg up for gold, which is what I'm depicting on its weekly chart below. Another rally would break gold out of its down-channel from 2013 but I think it will turn into a fake-out breakout and catch too many gold bulls leaning too hard to the long side. But if a rally can break above its January 2015 high at 1307.80 I'd turn more bullish, especially if a pullback holds at/above the top of its down-channel, currently near 1255.


Oil continuous contract, CL, Daily chart

Oil's daily chart below shows an a-b-c bounce pattern off the January 20th low and it achieved two equal legs up at 34.68 (with a high so far at 35.17). If it's to be just a correction to the decline, which fits as a 4th wave in the leg down from June 2015, then there's another leg down coming, which would be the 5th wave. The downside projection for a 5th wave would be near 20, possibly by early April, and if that happens it would be a very good setup for a stronger bounce/rally in oil. But at the moment the bounce pattern off the January low looks corrective, like the stock market, and that keeps the downtrend intact. Only with a rally above 38 would things start to look more immediately bullish for oil.


Economic reports

Thursday morning's economic reports include the unemployment claims numbers, productivity, labor costs and ISM Services. None are market moving but some of the data will be used by the Fed in their evaluation of inflation risks (although at this point to say inflation "risks" is probably not correct since the Fed would dearly love to see higher inflation, even above 3%). Friday morning's NFP report will be the big one and after today's ADP report there could be some whisper numbers looking for 200K instead of 180K. Just not too strong so that the Fed can stay on the sidelines.


Conclusion

Following Tuesday's strong rally and more or less a consolidation day today (except for a more bullish RUT) there is a pattern from last August and January that suggests we could see a turn back down. Combine this pattern with the end-of-month "AUM" rally, which typically leads to a decline into mid-month and we have a setup for at least a pullback following the strong bounce off the February lows.

But if the market does not start a more significant pullback on Thursday, Friday at the latest, we'll have a market that's speaking bullishly to us. We could simply get a bigger bounce that corrects the December-February decline before heading lower but there is a bigger bullish pattern that calls for another rally leg to new all-time highs. It's the more bullish possibility that is reason enough for bears to be cautious here.

Since this is a setup for at least a deeper pullback into mid-month, and potentially something much more bearish, I think it's very important for bulls not to get complacent. If you missed your opportunity to lighten up on your exposure to the long side and you were kicking yourself for not selling sooner, this is your second chance. A much stronger decline would have you kicking yourself that much harder. Set your stops now and don't let the market get past you. Enjoy the ride higher, if that's where we're going, but protect yourself on the downside.

We have as good a setup for shorting the market as you'll see and a negative close on Thursday would be the trigger to play the short side (sell rallies).

Good luck and I'll be back with you next Wednesday.

Keene H. Little, CMT

In the end everything works out and if it doesn't work out, it is not the end. Old Indian Saying